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Putting the Challenge in Challenger Banking

Challenger banks have taken the UK by storm.

It’s predicted that by the end of 2020 these banks - like Albaco, Monzo, Revolut and the dozens of others - will have a combined customer base of more than 35 million. That’s triple the number of users in 2019. While they have a handful of advantages over their traditional competitors, that doesn’t mean that it’s all plain sailing.The coronavirus pandemic saw 40% wiped off Monzo’s valuation and serious doubts about its future, while the Financial Times reports that fintech users are still in love with traditional high street banks and despite the impressive numbers (Monzo claims to onboard 55,000 new customers every week and Revolut has a reported valuation of £6bn pounds at the time of writing) challenger banks are facing an uphill battle.

Innovations and Changes in Regulation

All of that said, the challenger banks have a few tricks up their sleeves and the UK’s regulatory environment is making getting up and running faster and easier than ever. The Department of International Trade reports that the UK fintech sector generates £6.6bn in revenue per year and that there are 89,000 finance firms across the UK. For the past five years, the UK government has been using regulatory shifts to help bolster the move to digital banking and is a global front runner for its regulatory support. In 2015 we saw the UK become the first nation to implement a regulatory fintech sandbox to promote innovation in products and services. It’s been so successful that it led a host of nations - including Australia and Singapore - to announce their plans for fintech sandboxes. The past five years have seen that innovation mindset consistently being built on with an open-minded and internationally focused regulatory scheme, that includes the launch of the Payment Services Directive (PSD2) which inspired the creation of Open Banking and its subsequent wave of innovation. What makes this particularly interesting, is the level of success that changes, improvements and developments in regulation, especially PSD2, have had on the fintech sector in the UK. A report by EY shows that 94% of fintechs are looking to embrace open banking as a way of enhancing their services and 81% of those surveyed said it would be used to enable new services.

Challenger Banks Vs Traditional Banks

An open regulatory environment has helped challenger banks get a leg up on the competition but innovation hasn’t been fuelled entirely by changes in regulation. There is a central question: how do you make customers shift away from a bank they’ve been with for years and make first-time bank users choose your products? Access to capital and the ability to lend (especially in the face of coronavirus), is one of the biggest challenges that faces these digital-first banks. Not having a long-established customer list and pool of wealth to draw on for lending and growth, has had the effect of powering innovation. Gone are the days of paperwork and long waits and appointments in branches. The challenger banks are built around simplicity- lower fees, quicker set-ups, more transparency and user-friendly banking apps - and are competing with the big banks by offering cheaper deals, more flexibility and better service to win over customers. It’s hard to understate the power of digital and mobile-first banking. Perhaps the thing that most challenger banks have in common is the push for mobile first and monetising later. While services like Revolut and Monzo offer free and premium accounts, the business model of mass uptake and then monetisation is helping these challengers, and many others like them, grow rapidly. Part of this is down to niching being the new black. It’s easy to focus on the consumer-facing challenger banks but there is a whole separate set of challengers. Whether it’s Scotland’s own Albaco or bank-of-the-moment Starling, there’s greater competition at the SME end. In an effort to help bolster SMEs throughout the coronavirus, Starling has recently completed a new round of funding [that saw it raise €344 million to help it lend more support to its SME customers and it continues to be one of the fastest growing banks in Europe. At its core, one of the biggest advantages of the challenger banks are their ability to take control of the opportunities that traditional banks, because of their size and relative market dominance, have been neglecting.

Winning Over Customers (and retaining them)

If anything, the past few months have shown us that the dream run that 2020 was shaping up to be for many of the challenger banks has had the breaks slammed on in an ugly way. Challenger banks face some complex challenges, not least of all is how to monetise their user base when so many of them have been drawn in by the low fees and free accounts. And that’s exactly where the crunch lies. While these banks are gaining new customers, the traditional banks aren’t necessarily losing them. If we look at Monzo, which has the largest customer base among the challenger banks, its increasing growth still only puts it at 20 percent (or less than a third) of Barclays’ customer base. The challenge for banks like Monzo, Revolut, Starling and Albaco is that traditional banks still have faithful customers - even if someone runs every day spending through a challenger bank the chances are their savings and investments lie with a traditional bank. Both Monzo and Revolut customers have more than one banking app on their phone (80 percent for Monzo and 81 percent for Revolut) and chances are, the second app is from Lloyds, Barclays or HSBC. In fact, an analysis of the mobile banking behaviour of 688,000 people in the UK between 01 July and 30 September 2019 suggests that traditional banks have their heels firmly dug into the ground. As well as fighting for market share and not having yet obtained dominance enough to encourage customers to abandon their traditional banks, the challengers face difficulties from all sides including customer retention to shifting the culture of banking away from being able to go into a branch and talk to someone when you need a problem solved or to get a loan.

Where to from Here?

Across challenges and successes, it’s clear that the UK’s fintech scene is going to continue to thrive. While banks like Monzo may take a beating from challenges like the coronavirus, the UK’s pro-fintech regulations, which have seen Edinburgh grow into the second largest fintech hub in the country, will go a long way in ensuring consistent innovation. Earlier this year, Scotland’s fintech cluster became one of only three in the UK and Europe to be certified as a centre of excellence and also received a funding boost of more than £22 million. As countries start to pull through the coronavirus and the way society operates begins to change to be more digitally focused, it’s easy to see how through the sheer numbers, level of innovation and grit, that fintech can continue to evolve and thrive.